Are you rebalancing your portfolio too often?

Traditional wisdom has long dictated that you should rebalance your investment portfolio regularly. Doing so forces you to buy low and sell high—which is always a good idea. For instance, if you have a typical 60% stock and 40% bond portfolio, when the stock market rises, you’re forced to sell off some of your equities to return to your original allocation, thus locking in gains. And when the market plummets, you’re forced to buy into the market while it’s low.

But a recent study came to a surprising conclusion when it looked at  how often you should rebalance your portfolio: It turns out that if you have a high tolerance for risk, you may be better off rebalancing less often—or even not at all.

In the February, 2010 issue of the Journal of Asset Management, researchers Samuel Jones and Joe Stine of the Stephen F. Austin State University in Texas write that prior rebalancing studies may have lead investors astray. Many of the older studies used historical databases, which many researchers now agree is an inferior method to computer sim­ulations. But even the simulation-based studies didn’t properly take into account the risk tolerance of individual investors, Jones and Stine say, which is a big mistake.

They found that rebalancing regularly does indeed lower the volatility and risk you take when you invest, but that lower volatility may come at the expense of some possible up­side gain. In other words, if you can live with all the volatility, especially when your portfolio is on a big downswing, you could potentially come out a winner over the long run by just neglecting your portfolio, and not rebalancing at all.

If you decide to go with no or little rebalancing, you’ll be in good company: index-fund pioneer John Bogle, for one, follows such an approach in his portfolio. But make sure that you not only have a long-term time horizon, but the fortitude to resist panic attacks during the downturns and greed during the upturns. Indeed, if you are a rookie, you might want to stick with rebalancing until you’ve lived through a few market cycles.